External Influences

The business cycle

Economic activity does not grow in a straight line. It moves through a repeating cycle of expansion and contraction, and each stage changes what a business can sell, what it pays, and who it can hire.

The four stages

Four stages repeat, in order, though not at a fixed length. Growth — output and employment are rising; businesses expand to meet demand. Boom — output peaks; demand can outstrip supply, and prices rise. Recession — GDP falls for two consecutive quarters; spending and employment decline. Slump — output is at its lowest; unemployment is high, spending weak.

How the cycle affects a business

A business feels each stage through employment, prices and GDP together. A boom gives customers more to spend, but can make good staff harder to recruit. A recession usually means falling sales, so a business may cut costs, delay expansion or postpone hiring rather than over-stock for demand that has not returned.

Worked example: a furniture retailer’s sales have fallen for the second consecutive quarter — the economy is in recession. With incomes under pressure, customers delay large, non-essential purchases such as furniture, which is why many businesses cut stock and non-essential costs as soon as a recession is confirmed.

Government and the economy

Governments do not run businesses, but their decisions on tax, spending and interest rates reach into almost every one.

Government economic objectives

Governments pursue economic objectives such as increasing GDP, controlling inflation, and keeping unemployment low. To meet these objectives, they adjust taxes, spending and interest rates — and each adjustment changes the conditions a business operates in.

Tax and government spending

A rise in corporation tax reduces the profit a business keeps after tax. A rise in income tax reduces customers’ disposable income, which can reduce demand — particularly for non-essential products. Higher government spending can increase demand directly, through government contracts, or indirectly, through public sector wages.

Interest rates

A rise in interest rates raises the cost of borrowing, so a business with a loan or overdraft faces higher repayments immediately. It also makes saving more attractive to consumers relative to spending, which can reduce demand. A fall in interest rates has the opposite effect: cheaper borrowing encourages investment, and consumers have less incentive to save rather than spend.

Worked example: a bakery chain with an outstanding loan, planning to open two new stores, faces a rise in interest rates. Its existing loan repayments increase, and with less cash available and borrowing for the new stores now more expensive, it has less capital for expansion — which is why businesses often delay expansion when interest rates rise, even where demand has not changed.

Business and the environment

Business activity affects people who never chose to be part of the transaction — and the environment is where that effect is most visible.

Externalities

An externality is a cost or benefit of a business decision that falls on someone outside the transaction. An external cost might be air pollution from a factory, borne by nearby residents rather than the business or its customers. An external benefit might be a business-funded park, enjoyed by the whole neighbourhood.

Sustainable development

Sustainable development means meeting today’s needs without limiting the ability of future generations to meet their own. A business contributes to it by using renewable energy, reducing waste, or sourcing materials that can be replaced or recycled — choices that lower its environmental impact without necessarily raising its costs over the long run.

Legal controls and voluntary response

Governments impose legal controls — such as limits on factory emissions or rules on waste disposal — that a business must meet regardless of cost. Beyond the legal minimum, a business can respond voluntarily: adopting cleaner technology, publishing an environmental policy, or changing suppliers in response to pressure groups. Pressure groups cannot force a change in law, but a sustained public campaign can damage a business’s reputation enough to make voluntary change the cheaper option.

Business and ethical issues

Not every decision a business makes is judged only on whether it is profitable. Some are judged on whether they are right.

Profit versus ethics

An ethical issue arises when the most profitable choice and the choice most people would consider right are not the same. Paying the lowest wage a market allows, or buying from whichever supplier is cheapest regardless of how they treat their workers, may both raise short-term profit — and both may be considered unethical. A business that consistently chooses profit over ethics risks its reputation with customers, employees and suppliers alike, even where nothing it does is illegal.

Child labour and fair prices to suppliers

Two ethical issues appear often in Cambridge cases. The first is child labour in a business’s supply chain — even where a business does not employ children directly, using a supplier that does raises the same ethical question. The second is paying fair prices to suppliers, particularly smaller producers in developing economies who have little power to negotiate. In both cases, the ethical choice is often also the more expensive one in the short term.

Worked example: a clothing retailer can buy from a cheaper overseas factory with no independent labour inspections, or a more expensive factory audited for fair pay and safe conditions. Choosing the audited factory raises the cost of goods and is likely to reduce the profit margin unless the cost can be passed on or the ethical sourcing promoted — the retailer trades a lower short-term margin for a lower risk of the reputational damage that follows a supply-chain scandal.

Globalisation

Falling transport costs and fewer trade barriers have turned many national markets into one global one — for better and for worse.

Why globalisation happens

Globalisation is driven by falling transport and communication costs, fewer trade barriers between countries, and the growth of multinational companies willing to invest overseas. The result is a world in which a business can source materials, manufacture products, and sell to customers in different countries almost as easily as it can within its own.

Opportunities and threats

Globalisation gives a business access to new markets, cheaper suppliers, and a wider pool of labour and ideas. It also exposes that business to new competitors — including foreign businesses entering its own home market — and to risks it cannot control directly, such as a trading partner’s exchange rate or political stability.

Tariffs and quotas

Governments sometimes protect domestic businesses using tariffs and quotas. An import tariff is a tax on imported goods, which raises their price and makes domestic alternatives more competitive, while generating tax revenue — but it can raise costs for domestic businesses that rely on imported materials. An import quota limits the quantity of a good that can be imported, protecting domestic market share directly rather than through price, but does not raise government revenue as a tariff does.

Multinational companies

A multinational company does not just sell across borders — it produces across them, and that changes who benefits and who loses out.

Why businesses become multinational

A business might expand into other countries to access new customers, lower production costs, avoid import tariffs by manufacturing inside the target market, or reduce its dependence on a single economy. This scale of growth usually requires substantial capital, which is why multinational status tends to follow, not precede, a business becoming large.

Impact on the host country

A host country can gain new jobs, additional tax revenue, and investment in local infrastructure such as roads or training. Consumers typically gain more choice, and lower prices where the multinational competes on price.

Drawbacks for the host country

The same investment can draw customers away from smaller local businesses that cannot match a multinational’s prices or marketing. Profits earned locally are often repatriated — sent back to the multinational’s home country — rather than reinvested in the host economy.

Worked example: a large multinational supermarket opens its first store in a small town of independent grocery shops. The benefit is local jobs, directly and through delivery and maintenance contracts; the drawback is that its lower prices, from its buying power, may draw customers from independent shops that cannot compete. The net effect depends on whether the jobs and choice outweigh the loss of local businesses and the profit that leaves the town when repatriated.

Exchange rates

A business that buys or sells nothing abroad can ignore exchange rates. Almost no business is in that position for long.

Appreciation and depreciation

An exchange rate is the price of one currency in terms of another. When a currency appreciates, it rises in value — a given amount now buys more of a foreign currency. When a currency depreciates, it falls in value — a given amount buys less. Cambridge requires only that you identify the direction of change and explain its effect, never calculate a converted value.

The effect on importers and exporters

The direction of change affects importers and exporters in opposite ways. A business that exports goods priced in its home currency becomes more price-competitive abroad when that currency depreciates, since foreign buyers pay less in their own currency for the same goods; appreciation makes those exports dearer and less competitive. A business that imports raw materials priced in a foreign currency faces higher costs when its home currency depreciates, since it now takes more of its own currency to buy the same goods; appreciation makes imported materials cheaper and margins wider.